Debt management programs - are they right for you?

With total consumer debt over $11.68 trillion, debt is a pervasive part of American culture. According to a poll conducted by the Associated Press, half of the Americans surveyed said they worried about their debt; 42% saying their debt caused them a "great deal" of stress. One in five said they obsessed about what they owed most or all of the time. Most consumers in our economy are living paycheck to paycheck, barely covering their monthly expenses.

All it takes is one unanticipated event, like a layoff or medical disability, to create a vicious cycle of debt. Many consumers have found themselves trapped by such debt that they don't know how to get out from under; so they turn to increasingly popular debt management programs for assistance. Where do you stand? The fact that you are reading this indicates you have some concerning debt issues.

Ask yourself the following questions to see if you may be in over your head:

Do you live paycheck to paycheck?
Are you unaware or unsure of the total amount of debt you owe?
Have you paid late fees and/or over-the-limit charges at least twice in the past year?
Are your debt payments (other than your mortgage or rent) more than 20% of your gross (before- tax) income?
Have you received phone calls from creditors about overdue bills more than once during the past six months?
Do you pay only the minimums - or less - on your cards and other bills?
Would you be unable to meet your financial obligations for three months following a decrease in income or a costly emergency purchase?
Are money problems causing distress or conflict at home and/or work?
Are you lying to your partner or other family members about your debt?
Are you at or near your credit-card limit(s)?
Have you borrowed from one credit card or taken a cash advance to help pay off another credit card at least once in the past year?
Are you draining your savings or retirement accounts to pay your bills?
Are you charging a larger amount each month than you are paying off?
Is your income shrinking while your credit card balances are growing?
Are you using credit to pay for essentials like food, rent, or gas and you can't pay the bill in full each month?
Are you using pay-day lenders or other high-rate, short-term loans?

There are different options when it comes to debt management, namely: Debt Consolidation, Credit Counseling, Debt Settlement or Negotiation, and Bankruptcy.

Debt Consolidation and Credit Counseling:

There is little difference between these two debt management strategies. Both will negotiate past interest charges and late fees and will negotiate a better interest rate. In both cases you would make one monthly payment to the credit counseling or debt consolidation company for them to pay on your accounts. Both options will also deal with creditors and collectors at your request. The average payment plan lasts 4-7 years. At the end of that period, they guarantee all of the debts that were included in the original plan will have been paid off. What they don't tell you is that you will be paying more than the minimum on each account and they will make between 8% to 25% commission from the money they "save you" in the end.

Most credit counseling companies are simply debt collectors for original creditors. VISA began the credit counseling industry (due to the high percentage of defaults). Creditors market this service as "free" or "non-profit" in order to lure debtors into paying their debts back. Don't be fooled. They still make a huge profit but mask it as mandatory donations or fees to "cover operating costs."

The relief these strategies offer is very temporary and will only cost you more in the long run. Not to mention the damage that it will do to your credit the next 7-10 years. It is better to try and negotiate interest rates and late fees yourself and instead of paying a debt management company, apply that money to the debt itself.

Debt Settlement or Negotiation:

Debt settlement is a process of negotiating with creditors to accept an amount as settlement for less than full balance. What happens is you stop paying your bills. The money that would have gone toward the bills instead goes to the negotiator in an escrow account. The negotiator watches your account status and waits until the account is just about to be charged-off, or until enough money is in the account to make an offer. At that point a negotiation is made to pay 40-60% of the balance. Most creditors will take it, knowing that is the only money they are likely to get from you. Other creditors won't accept settled debts or negotiations.

Once the terms and amount are agreed upon in writing, the debtor pays the creditor, and the unpaid portion is forgiven by the creditor. The settlement amount is usually paid in one lump-sum payment, although creditors may offer structured settlements (settlement amount paid over several payments).

Debt settlement one of the fastest and most effective ways to resolve debt issues. That being said, your credit will take a hit. As you stop paying your bills, you will get dinged with late pays. Once a pay off amount is negotiated, your credit report will say "settled"; not a favorable listing. Although some creditors agree to report the debt as "paid in full" or "paid as agreed" once the settled payment is made. But even if your credit report does take a hit, staying in debt with the higher possibility of default isn't good for your credit either.

Bankruptcy Types:

While bankruptcy has become more common and doesn't seem to carry the same negative social stigma that it used to, it still carries a negative financial stigma. A bankruptcy will follow the filer for years and carries many negative consequences whether it is a Chapter 7 or 13. The differences between the two chapters are as follows:

Bankruptcy: Chapter 7

A complete dismissal of all debts that qualify for discharge. Most debts can be discharged (wiped clean) in a bankruptcy. There are some debts that don't qualify like child support, student loans, tax liens and fines incurred from criminal activity. There are stipulations on secured debt like homes and cars, but most often Chapter 7 filers get to keep these assets. Most filers opt for Chapter 7, but under the new bankruptcy laws, most will not qualify and will have to file for Chapter 13. The bankruptcy court decides, through a means test, whether or not you can afford to pay your debts (even if reduced) through a payment plan.

Bankruptcy: Chapter 13

A re-organization of debts set on a payment plan. The filer pays debts down, at reduced rates, over a 3-5 year period. The amount the filer pays back is based on a means test. The IRS decides what the filer's living expenses should be and the remainder goes toward the debt. If any debt remains at the end of the payment period, it is discharged. A Chapter 13 shows more personal liability, but is still extremely negative because it proves that you could not fully pay off your debts. The reporting time starts at the beginning of the payment period. At the end of that period, when the remaining debts are discharged, a 7 year reporting period begins.

There are many "professionals" who maintain that a Chapter 13 is only reported for 7 years total. It is reported for 7 years after the debt has been discharged. They overlook the 3-5 year payment period prior to that.

Section 605 of the FCRA (a-1) titled "Requirements relating to info contained in consumer reports" contains detailed information on reporting time for bankruptcy. If even one payment is missed, then the bankruptcy could be dismissed (cancelled by the court) but it would still be reported for 7 years. Maybe that's where people get the idea that it may only be reported for 7 years.

Due Diligence to pay off debts:

It is in your best interest to do everything you can to pay off your debts; as long as you have been making consecutive payments. Remember, it is not wise to pay on old debts that haven't been paid on or acknowledged for a while. There are many calculators to help you create a budget and re-prioritize your debts. Yes, it will take discipline, but you will be better off in the long run and so will your credit.

If, after trying these options, there still doesn't seem to be an end in sight, then you may want to consider getting assistance from a lender or debt management company.

Consolidation Loan:

A consolidation loan is not to be confused with debt consolidation. A consolidation loan is where all debts are rolled into one with an average interest rate. All account information is turned over to the lending establishment who pays off debts with the loan. You then make one monthly payment to the lender. This can be a good thing if you can qualify for a lower interest rate. The convenience of only one monthly payment is also appealing. Often homeowners will consolidate through a HELOC (Home Equity Line of Credit). Interest rates are usually lower and there are added tax benefits. The problem is all of their unsecured debt is now secured by their home which they could lose if they default on the payments to the lender. Another option is to consolidate through a Conventional Loan (like a Signature Loan). You do not have to secure this type of loan with any collateral; however, rates usually aren't as good and there are no tax benefits. Consolidation loans are a good option for many people; however, it is tempting to spend the extra money that you would be saving on a lower interest rate instead of applying it to your debt. A consolidation loan won't affect your credit, other than the initial inquiry when you apply. Typically a debt consolidation loan without collateral is like a unicorn; people question their existence.